On March 30, 2022, the U.S. Securities and Exchange Commission (the “Commission” or “SEC”) proposed new rules and amendments regarding special purpose acquisition companies (“SPACs”), shell companies, and disclosure related to projections. The proposed new rules and amendments would, among other things, if adopted:
A known focus of Commission Chairman Gary Gensler since May 2021 when he discussed devoting significant Commission resources to addressing issues in de-SPAC transactions to the House Appropriations Committee, the proposed rules and amendments would require more fulsome and transparent disclosure in such transactions. The Commission’s goals appear to be twofold: first, to make the disclosures involved in de-SPAC transactions more analogous to those in a traditional IPO process; and second, to more prominently highlight the potential conflicts of interest between the sponsor of a SPAC and its public shareholders. Chairman Gensler was quoted as saying “[f]or traditional IPOs, Congress gave the SEC certain tools, which I generally see as falling into three buckets: disclosure; standards for marketing practices; and gatekeeper and issuer obligations. Today’s proposal would help ensure that these tools are applied to SPACs. Ultimately, I think it’s important to consider the economic drivers of SPACs. Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO. Thus, investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.”
The public comment period will remain open for 60 days following publication of the proposing release on the SEC's website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
SPACs are typically shell companies formed for the purpose of merging with or acquiring a private target company. Many companies and investment bankers believe that the SPAC transaction structure allows private companies greater certainty regarding valuation and a quicker “going public” timeline than a traditional IPO while offering the ability to provide and use projections in the de-SPAC filings made with the Commission. As a result, certain private companies have favored the de-SPAC transaction structure over a traditional IPO.
However, during the recent surge in SPAC formations and completions of de-SPAC transactions, a variety of market observers have raised concerns about, among other things, the nature and disclosure of SPAC sponsor compensation; potential conflicts of interest that could incentivize SPAC sponsors to enter into de-SPAC transactions that are “unfavorable” to public shareholders; the use of projections that, in the view of some market participants, appear to be unreasonable, unfounded or potentially misleading; and the lack of a traditional gatekeeper similar to the role played by underwriters in IPOs.
As a result of such concerns and as the number of SPAC IPOs and de-SPAC transactions increased exponentially over the past 30 months, the Commission already issued guidance on SPACs five times since December 2020, leading up to the current, more comprehensive rulemaking proposal.
The new rules and amendments, if adopted as proposed, would:
If adopted as currently proposed, the new rules and amendments would represent material changes in the rules that apply to SPACs, and could significantly affect their appeal to target companies as an alternative way to go public. The proposed rules could potentially eliminate two of the perceived benefits of a de-SPAC transaction for a private target company: a quicker “going public” timeline than a traditional IPO and the ability to provide and use projections with the “safe-harbor” protections of the PSLRA. The Commission stated that, if adopted, such rules and amendments “could help the SPAC market function more efficiently by improving the relevance, completeness, clarity, and comparability of the disclosures provided by SPACs at the initial public offering and de-SPAC transaction stages. . .”
If adopted as proposed, will the proposed rules and amendments align the de-SPAC process so closely to an IPO that it substantially diminishes the appeal of de-SPACs as an alternative to a traditional IPO? SEC Commissioner Hester Peirce, who was the lone dissenter from the Commission’s proposal, appears to think that could be the case. She argued that the proposal went beyond enhancing investor disclosure, saying that “[i]t imposes a set of substantive burdens that seem designed to damn, diminish and discourage SPACs because we do not like them, rather than elucidate them so that investors can decide whether they like them.”
While the Commission has brought relatively few enforcement actions concerning SPACs, shareholders have brought a variety of different types of claims regarding SPACs and de-SPAC transactions. These claims include, among others: (i) lawsuits threatening to block a de-SPAC transaction due to alleged failure to disclose material information in Form S-4, most often information about purported conflicts of interest or financial information regarding the target company; (ii) securities class action claims for violation of the federal securities laws regarding misstatements or omissions in public disclosures concerning the target company and/or the SPAC sponsors; (iii) breach of fiduciary duty claims claiming that the SPAC structure creates an inherent conflict of interest between the SPAC sponsor and the SPAC board, on one hand, and the SPAC investors, on the other hand.
Commentators, including many noted in the Commission’s release, have been increasingly vocal with concerns regarding transparency for SPAC shareholders regarding conflicts of interest and financial projections concerning target companies. These first two categories of lawsuits noted above are based largely on those concerns. While not necessarily unique to SPACs, the relative lack of guidance regarding disclosure requirements and the recognized potential for conflicts make SPACs and de-SPAC transactions fertile ground for such lawsuits. Adoption of the Commission’s proposed rules could certainly impact these disclosure-based types of suits by taking away some of the shareholders’ arguments that material information about conflicts and projections was omitted. Such lawsuits are unlikely to go away completely, however, given that they are regularly brought even in the traditional IPO setting to which the Commission’s proposed SPAC rules seem to aspire.
How the proposed rules might affect lawsuits brought on a breach of fiduciary duty theory, such as the much-discussed Multiplan litigation in Delaware’s Court of Chancery, is less than clear. In that case, the court found that where SPAC sponsors and directors receive economic benefits not shared by all SPAC investors, a higher level of scrutiny—entire fairness—applies in assessing the sponsor’s and directors’ conduct. The decision, however, left open the possibility that disclosures that render SPAC shareholders “fully informed,” which appears to be the Commission’s mission under the proposed rules and amendments, might result in application of the more deferential business judgment rule.
One other type of lawsuit concerning SPACs—those claiming that SPACs are investment companies under the Investment Company Act and must be registered as such—is directly addressed by the Commission’s proposed rules. While the parties in these pending cases are debating the Commission’s view on the applicability of the Investment Company Act, the proposed rules would seem to resolve the dispute by creating a “safe harbor” from investment company registration if certain requirements are met.